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We have all heard the old saying "Don't put all your eggs in one basket". As simple as it sounds it is true. Now I am not suggesting mutual funds by any means. When diversifying it's important to put your money in stocks with two characteristics, growth and value.

Let's quickly review these definitions. What is growth? Simply put it is how fast a company is growing. Let's take Mc Donald's for instance. There is one on every corner. So in order for the company to double it will need to open twice as many stores. Not very likely to happen any time soon. Now on the other hand you hear of a small company that is gaining popularity like netflix. Its obviously a competitor with other companies such as Blockbuster and Hollywood video. You notice it is becoming more popular and seems to be the way of the future.(or at least until a better technology comes out). You also notice it has only reached a small part of the United States let alone the world. With this information you can now conclude it has growth potential.

Now value is the making sure your stock is not over priced. It is functioning on sound principals. Mc Donalds is obviously here to stay. It will not disappear and is functioning on sound principles. But how is it priced?

That's where the P. E. Ratio comes into play or price to earnings ratio. Simply put the price of the stock compared to how much that stock earns. So if the stock is earning 50 cents a share annually and you have a PE ratio of thirty (Thirty times earnings) the stock is worth 15 dollars.

Several factors dictate a stocks P.E. Ratio. If a company is growing very quickly its P. E. Ratio is typically higher. If a stock is growing slowly its P. E. ratio is lower. That's why P.E. ratios are lower during recessions and higher during bull markets.

Now that you can pick a good stock how many stocks should you have in your portfolio? The answer is at least five. If you spread your money between five stocks you typically can't go wrong. Out of five stocks three will rise, one will typically stay flat, and one will go down. And those are the basics of diversification.

Learn more about this author, Channing Merced.
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